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  Business Times 2 Nov 07
Who will break the climb of oil prices?
Oil producers insist that supply is adequate and blame the price escalation on speculators
By G Panicker

SOME time soon, the nominal price of a barrel of oil will reach three digits. Normally, a cold winter can swing the price upwards by as much as US$8, according to investment bank Goldman Sachs. So with US crude prices at almost US$96, after rising more than 10 per cent in one week and one-third since August, we may not have to wait long.

Crude prices have ignored all calming gestures so far. The Sept 11 meeting of the Organisation of Petroleum Exporting Countries (Opec) in Vienna was all about cooling prices. Yet, the US futures breached the psychological mark of US$80 the next day. A little more than month, later the price rose past US$90!

Now, the debate is about how close we are to an all-time high in real dollars since futures began trading in 1983. Prices posted a peak of US$101.70 in April 1980 for another type of crude. Technicalities apart, even the current levels should shock the world that was dismissive of Goldman Sachs' warning in 2005. The firm's Arjun Murti said that crude prices had entered the early stages of a 'super-spike era' and could surpass US$105 a barrel. Now, Opec members are among those talking about that distinct possibility.

While views on supply are sharply divided, oil producers routinely insist that supply is adequate and blame the price escalation on speculators, refinery bottlenecks and geopolitics.

Somebody has to break the relentless march of oil. That job falls to Opec. While the producers alone cannot be faulted for the runaway prices,their production cut by 1.7 million barrels per day last year has partly caused the current price surge in the face of weak non-Opec output and inventory drawdown by consumers.

Prices, which ranged between US$10 and US$20 in the 1990s, have vaulted US$45 from the lows this year, a price jump which both the US as well as China view as excessive.

Even oil company executives are mystified. Exxon chief executive Rex Tillerson said recently: 'We have no trouble in finding oil. There is something else going on that I don't get.' A Royal Dutch Shell official has also difficulty in explaining the price spiral but attributed it to speculation.

When prices were around US$80, Saudi oil minister Ali Al Naimi said: 'The markets are in turmoil, and let's leave it at that.' But it has gone up another US$16 since. Can the world afford to 'leave it at that' when prices go crazy in a typical weak demand period?

Sure enough, the eroding US dollar value has fuelled demand for oil and other commodities. The Federal Reserve's sharp cut in interest rates to resuscitate a sub-prime-tossed economy has weakened the US dollar further. The new reduction could spur more buying by speculators riding on abundant global liquidity and market volatility.

Still, the missing consumer protests which accompanied high prices, at US$35 a barrel in year 2000, may have lulled Opec into inaction. US pump prices have been down from their highs after the busy driving season, and outside the US, stronger currencies have given importers oil at a discount. Generally, the West has become less energy intensive and their consumers spend relatively less of their incomes on energy.

But all that will hardly erase the impression that Opec has chosen to drip-feed the world going through a demand shock. The rich consumers' energy watchdog, the International Energy Agency (IEA), noted that there was a shortfall of 360,000 barrels a day between July and September. In the comparable period in the previous five years, supplies increased at 280,000 barrels. Since the end of June, oil inventories have fallen 11.7 per cent or 41.4 million barrels in the US.

Oil stockpiles with members of the Organisation for Economic Cooperation and Development (OECD) has dipped below the five-year average but an Opec official contended that those supplies of 53.5 days are adequate. Asia is not spared. China too is experiencing a shortage at some pumps.

According to experts, when oil for near delivery costs more than supplies set for farther into the future, it shows that market tightness that has developed.

So, Opec's hands-off policy only emboldens speculators to make bigger market bets, particularly when some players regard that this market is for real and when it is precariously sensitive to every bit of bad news. Certainly, new geopolitics events - Turkish troops massed at the border of Iraq to attack Kurdish PKK rebels in Northern Iraq - has given speculators a fresh excuse, though oil flow from that area is rather small. But speculators, visualising wider regional trouble, have factored US$10-20 into the price of oil, chiefly resting on Iran's nuclear ambitions. The Iran tangle will endure. Generally, US presidential election front runners have backed tough measures against an unbending Teheran.

US President George W Bush has spoken about Iran's nuclear ambitions in the context of 'World War III' and Vice-President Dick Cheney talked about 'serious consequences' should Iran go down on the nuclear path. Defiant as ever, Iran has ignored even the latest round of sanctions that extend to units in its military. Some say that only tough sanctions involving the oil sector, which gives Teheran 90 per cent of its hard currency earnings, will work. But prices will go ballistic if such measures are even contemplated.

In the circumstances, it falls on Opec, as a global economic partner, to ease the deficit in a way that it will not be hurt badly on the rebound. Demand remains strong with the global economy expected to grow at 5.1 per cent this year. While it is forecast to slow to 4.8 per cent next year, that still is handsome growth requiring ever more oil.

Sure enough, a falling US dollar cuts into Opec's buying power and has brought home serious inflation worries to the producers. But prices have run up faster than the erosion in in the value of the US currency. A hint of more supplies should not hurt prices much. After all Opec appeared happy with US$60 last year.

Perhaps, as some critics contend, the producers have developed a taste for high prices and are willing to test how high a price the world economy can bear before it buckles. For a 1970s style demand destruction and creation of a supply cushion, prices will have to jump to US$135 for New York crude, according to the 2005 Goldman forecast.

Opec says that it does not favour prices at this level. But even the last increase in supply, which was dubbed too little, too late, came at Washington's request.

In effect, Opec's measured approach has tightened supplies in a market partly deprived of oil from Nigeria and Iraq. And strangely, it is now some of the oil producers who raise the possibility of US$100 price for oil, still pointing a finger at a moving target. Shouldn't they be sending strong signals to take the wind out of the speculators' sails, instead of paving the way for a self-fulfilling prophesy and a major price event?

The writer is with BT's foreign desk
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